China: Issues in China on Internet financial products (IFP) derived from notes

Last Updated: 5 May 2015
Article by Zhong Xin and Chen Fushen

Along with the rapid development of Internet finance in China, the assets that feed into the creation of Internet Financial Product (IFP) are also expanding. Among these assets, note's specialty includes its abstract principle, formality requirement and literal interpretation principle. Note is also suitable to be structured, making it a very popular asset. As a result, numerous IFP with notes as supporting asset continuously ballooned. In light of our recent experience in executing many notes IFP, we have summarized some of heated legal issues as follows.

  1. Two Business Models

Currently, notes IPF's main business model consists of two categories:

Beneficiary rights transfer

It means creating a beneficiary right for all incomes received and generated from notes, and transferring such right in its entirety or via creating different layers to investors. More specifically, the aforementioned beneficiary right is a contractual right that possesses or has the nature of debt; generally includes: (a) any income under the note, including any payment reminder from the note holder; (b) any income generated via receivables factoring etc.; (c) any income generated via guarantees with the note (if applicable); (d) in case of note payment default, any income generated via claims against the endorser, note issuer or any other debtors; (e) any income generated via sale of or other dealings with rights under the note.

This business model is special because investor and originator only possess or have a contingent creditor-to-debtor relationship, while originator's payment obligation to investor is only limited to the extent of any income generated. When the note fails to generate income due to its riskiness, originator will not intervene with its creditability and, thus, becomes a debtor without guarantee to investor's principal payment and expected returns.

P2P transfer

It means creating a P2P relationship backed by notes. More specifically, creditor-to-debtor relationship is formed by investors acting as lenders and note holder acting as borrower. Within this creditor-to-debtor relationship, provision will stipulate any income generated from note shall be considered the first source of repayment and the note shall be pledged. In addition, a creditor-todebtor relationship also exists between SPV and note holder, provided the business model is the SPV transferring such creditors' right in its entirety or via creating different layers to investors.

This business model is special not only because it involves notes as pledged asset (mentioned in the following), but also because the legal relationship and business model is similar to regular P2P lending. As a result, P2P transfer will likely fall within the realm of P2P-related regulations.

  1. Two Types of Guarantee

Whether using receivables transfer method or P2P transfer method, by relying purely on creditor's right, it is difficult for investors to truly obtain the legal right under the note. As a result, using notes as pledged asset is vital to solidify the legal right to investors under both methods. Under limitations imposed by the Property Law and the Negotiable Instruments Law, payment under notes and pledge endorsement are absolutely necessary for the validity of such pledge. However, due to the sheer number of investors, it is impossible to realise note possession and endorsement for every single investor. In light of this problem, two solutions are provided.

Pledge delegate model

This model involves the following procedures: (a) investors lend to originator; (b) originator uses its bank acceptance drafts as pledge to platform company; and (c) the fi nancing document specifi es that originator and investors confi rm such platform company's role as a security agent to exercise creditor's rights on behalf of all investors, while holding the pledged asset and participating in the endorsement.

One of the lenders acting as the security agent happens frequently within syndication loans. The advantage is that there is no need to involve a company to act as security agent; while perfecting creditor's rights over the pledged asset among large group of investors without any change of parties in the underlying transaction. The platform company can act as pledgee under endorsement to exercise any right under the notes, to monetise and negotiate with pledgor on debt repayment with the monetised sum.

However, one thing worth mentioning is for syndication loans, the security agent will usually be one of the lenders. While this is not the case in note IFP, since the platform company is not one of the lenders. It still remains some uncertainties whether the platform company would be subject to the same treatment as security agent in syndication loans under judicial practice.

Counter-guarantee model

This model involves the following procedures: (a) investors lend to originator; (b) introduce third-party guarantor to provide guarantee for the loan; and (c) originator uses the notes as pledge to the platform company for counter-guarantee.

This model adopts counter-guarantee so as to allow large number of investors to gain more priority in their rights over notes. In comparison with the pledge delegate model, this model achieves more certainties and completeness.

More importantly, as mentioned before, under these models, originator's current source of repayment comes from the notes. Since notes under counterguarantee cannot monetise at maturity, such guarantee needs to be terminated before maturity or using short-term financing as bridge. Besides, introducing a guarantor company into the picture will more or less increase operating costs.

  1. Two Note Dealings

Beside civil litigation, it is essential to determine and understand the note dealings, so as to comprehend the business model and reduce legal risk. Among many dealings, two of them are particularly important and typical – pledge endorsement and delegate endorsement.

Pledge endorsement

Pledge endorsement means the endorser acting as the pledgor and the opposing party acting as pledgee, to specify the right of pledge. For notes pledge, its validity shall rely on the amended laws instead of the old ones. Such pledge shall become valid upon delivery in accordance with the Property Law, or preferring special law to common law, such pledge shall become valid upon endorsement in accordance with the Negotiable Instruments Law. There is still controversy over this issue. It is prudent to make endorsement a required step.

In practice, as mentioned above, since notes normally come from the note agents' readily collected notes, executing notes pledge endorsement will adopt the following two methods: (a) pledgor's endorsement is done before receiving the notes, after collecting the products, pledge endorsement is done by the security agent or counter-guarantor; or (b) upon receiving the notes, notes agent or platform company irrevocably delegate to endorse on behalf of the pledgor. The latter method will lead to the holder of the notes being different to the endorser, causing noncontinuity in the endorsement process and, thus, diminishing the power of the pledge endorsement.

Delegate endorsement

Delegate endorsement is one of the methods that involve using a delegate, the note document stipulates the right of pledge belongs to the delegate. This method of endorsement avoids concurrence of delegate relationship by which the Negotiable Instruments Law or the Civil Law shall govern.

Here a custodian bank will normally be the note service bank. Such delegate by note creditors is irrevocable. The custodian bank will exercise creditors' rights, including presentation for payment, collection, recovery, delivery and collection through another, and subsequently transfer such payments received to relevant custodian bank accounts.

  1. Litigation for two types of notes

Note IFP's essential source (and truthfully the only source) of repayment comes from the notes, so any litigation involving a note will cause severe impact on its exchangeability. In light of this, we hereby introduce the types of litigation and their basic contents:

Litigation over note itself

Litigation over note itself means any litigation resulting from the note itself and its contents. Such litigation is primarily based upon the notes itself, so litigation holds despite any change of legal relationships involved.

Generally speaking, litigation over note itself mainly includes the following situation: (i) note becomes void due to its content lacking legallyrequired format, such as lacking necessary provisions or including certain provisions that would make it void; (ii) litigation involving forged or altered notes; (iii) rights under notes has been terminated or become invalid, such as notes being fully repaid, offset as stated or exempted, exceeding the legal time frame for repayment claims etc; and (iv) for long-term notes, originator refuses to make payment as maturity has not been reached.

Litigation between parties

Litigation between parties means any litigation between debtors and specified creditors. This can be further categorised as follows: (a) originator fails to pay in situations (i) originator declared bankruptcy; and (ii) a non-delegate is exercising power over originator or a delegate is over-exercising its power over originator. (b) reasons for originator refusing to pay include: (i) note holders lost its power to execute the note; (ii) note holders obtained the note through illegal means, such as unlawful dealings, unlawful state of mind, or without paying (except for tax, inheritance or gifting); (iii) note holders knew about the origin of the notes, which originates from litigation between agent and originator.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
 
Some comments from our readers…
“The articles are extremely timely and highly applicable”
“I often find critical information not available elsewhere”
“As in-house counsel, Mondaq’s service is of great value”

Related Topics
 
Related Articles
 
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions